Question

Worley Company buys surgical supplies from a variety of manufacturers and then resells and delivers these supplies to hundreds of hospitals. Worley sets its prices for all hospitals by marking up its cost of goods sold to those hospitals by 7%. For example, if a hospital buys supplies from Worley that cost Worley $100 to buy from manufacturers, Worley would charge the hospital $107 to purchase these supplies.

For years, Worley believed that the 7% markup covered its selling and administrative expenses and provided a reasonable profit. However, in the face of declining profits, Worley decided to implement an activity-based costing system to help improve its understanding of customer profitability. The company broke its selling and administrative expenses into five activities as shown:

Activity Cost Pool (Activity Measure)	Total Cost		Total Activity
Customer deliveries (Number of deliveries)	$	567,000	7,000	deliveries
Manual order processing (Number of manual orders)		702,000	9,000	orders
Electronic order processing (Number of electronic orders)		325,000	13,000	orders
Line item picking (Number of line items picked)		968,000	440,000	line items
Other organization-sustaining costs (None)		630,000
Total selling and administrative expenses	$	3,192,000

Worley gathered the data below for two of the many hospitals that it serves—University and Memorial (each hospital purchased medical supplies that had cost Worley $31,000 to buy from manufacturers):

	Activity
Activity Measure	University	Memorial
Number of deliveries	12	24
Number of manual orders	0	44
Number of electronic orders	15	0
Number of line items picked	150	280

Required:

1. Compute the total revenue that Worley would receive from University and Memorial.

2. Compute the activity rate for each activity cost pool.

3. Compute the total activity costs that would be assigned to University and Memorial.

4. Compute Worley’s customer margin for University and Memorial. (Hint: Do not overlook the $31,000 cost of goods sold that Worley incurred serving each hospital.)

Answer 1

Solution 1:

Computation of Revenue - Worley Company
Particulars	Universal	Memorial
Cost of goods sold	$31,000.00	$31,000.00
Markup (7%)	$2,170.00	$2,170.00
Revenue	$33,170.00	$33,170.00

Solution 2 & 3:

Determination of activity rate for each activity & allocation of overhead
Activity	Estimated Overhead Cost	Activity Base	Usage of Activity Base	Activity Rate	University		Memorial
					Usage	Allocated Costs	Usage	Allocated Costs
Customer deliveries	$567,000.00	Nos of deliveries	7000	$81.00	12	$972.00	24	$1,944.00
Manual order processing	$702,000.00	Nos of manual orders	9000	$78.00	0	$0.00	44	$3,432.00
Electronic order processing	$325,000.00	Nos of electronic orders	13000	$25.00	15	$375.00	0	$0.00
Line item picking	$968,000.00	Nos of line item picked	440000	$2.20	150	$330.00	280	$616.00
Others	$630,000.00	No allocation
Total	$3,192,000.00					$1,677.00		$5,992.00

Solution 4:

Computation of Customer margin - Worley Company
Particulars	Universal	Memorial
Sales Revenue	$33,170.00	$33,170.00
Cost of goods sold	$31,000.00	$31,000.00
Gross Margin	$2,170.00	$2,170.00
Selling and administrative expenses	$1,677.00	$5,992.00
Customer margin	$493.00	-$3,822.00